Nifty has been exhibiting lackluster behaviour and has been stuck in a 3% range in the past 5 ? 6 sessions. On the Future Open Interest (OI) side, it has been constantly adding OI while witnessing a sporadic drop in between.
Volumes have been much lower compared to the historical averages. Most importantly, implied volatilities (IVs) have been trading at the lower end of the band for an extended period of time. The current market scenario seems apt for a one sided directional break out.
While the low implied volatilities and strong Put call ratio (PCR) point to a possible upside break, the excessive writing at very low IVs point to some complacency. A Doji has also been formed on the weekly charts citing a power struggle between the bulls and bears. Hence we maintain a neutral view on the market while expecting a large imminent price movement, either up or down but uncertain of the direction.
We expect an increase in the IVs of the options to outpace the time value erosion. Hence considering the Option Open interest spread across strikes, sentiment indicators set-up and low IVs we advise going long on the 5,500 June Straddle.
This unlimited profit – limited risk strategy entails buying the 5,500 June CE at R73 and the 5,500 June PE at R92 hence entailing a combined cost of R 165.
Execution of one lot would incur a cost of R8,250 which is also the maximum loss. Pay-offs would improve as we move away from the 5,500 mark.
The resulting pay off would have breakeven at 5,665 on the upside and 5,335 on the lower side. Loss would be incurred if Nifty ends the June expiry within these levels.
One can also potentially close out one side (call or put) and change the payoff profile of the straddle to a long put or long call as the series progresses. An increase in volatility would have a positive effect on the strategy while a further decrease in volatility would have a negative effect.